1. will shift to the right if the goods produced by the government are not perfect substitutes for privately produced goods and there is less than full employment.
2. will shift to the right if those paying the taxes that finance the expenditure have a higher marginal propensity to consume than those receiving the benefits.
3. will shift to the right permanently even if there is price flexibility and full employment.
4. will always shift to the right.
Choose the correct option.
The statement produced by option 1 the only one that has any chance of being true. The IS curve can shift permanently to the right only if there is less than full employment---otherwise the price level will adjust to ensure that it passes through ZZ at the full-employment level of output. If the government expenditure takes the form of a transfer from taxpayers to poor people who do not pay taxes the IS curve will shift to the right if the marginal propensity to consume of the recipients of the funds exceeds that of those paying the taxes---the opposite of what is specified in option 2. If goods supplied to the private sector by the government expenditure are not perfect substitutes for privately produced goods, there will not be complete crowding out and total private plus public consumption and investment expenditure will increase.
If the exchange rate is flexible, there will still be rightward pressure on the IS curve under option 1 but the effect of increases in income on the demand for money will lead to an attempt by domestic residents to accumulate money by selling assets abroad. This will lead to an appreciation of the real exchange rate which will shift IS back to its original position, crowding out the effects on output of the increased government expenditure. When the exchange rate is fixed these changes in the real exchange rate will not occur because the government will be forced to provide the additional money balances demanded in response to the increase in income (or prices if there is full employment) by accumulating reserves of foreign exchange to maintain the fixed exchange rate---equilibrium is determined by the intersection of the IS curve and the ZZ line.